Venture Capital Funding And Private Equity In India

Venture Capital Financing & Private Equity Financial Services and Markets 04/24/09

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ET – April 03, 2007 • • • •

VC / PE investments cross $2 bn in Q1 $2.4 bn in 78 deals ($1.4 bn across 69 last year) This does not include real estate investments! With new funds coming in, total investments during the year 2007 likely to cross $ 10 bn mark • Segments are – IT, Mfg, Financial Services, Engg. & Construction, Transport & Logistics • Source: Venture Intelligence India… 04/24/09

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BIG DEALS

• $500 mn – NYSE, GOLDMAN, General Atlantic and SOFTBANK in NSE • Rs. 820 Cr – Khazanah National hiked its stake in IDFC to 9.95% • Rs 100 Cr – Kotak Mahindra Bank’s Private Equity Group invested in DRS Logistics • $82 mn ADM invested for a 10% stake in SKNL • Rs. 125 Cr – RAMKY Infra raised from IL&FS Investment Managers & SABRE-ABRAAJ Fund 04/24/09

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TiE- The IndUS Entrepreneurs • How & when it all started? Indian Professionals waiting in Airport lounge for a Dignitary in 1992 • TiE is not for VCF but Angel Investing ! • Members – 600 with Chapters in Boston, Austin and Los Angeles – 20 institutions - leading Silicon Valley Venture Capital Investors, law firms, accounting firms and banks

• 50 % Business Plans in S Valley from Indians! • Vinod Dham, Sailesh Mehta, Kanwal Rekhi, et al 04/24/09 Venture Capital Finance 4

The Entrepreneurial Connection • East Meets West in Silicon Valley • by Gurmeet Naroola • Tata McGraw-Hill publication-2001 • Prakash Bhalerao (Ambit Design Systems), Sabeer Bhatia (Hotmail, Arzoo), K B Chandrasekhar (Exodus), Deepak Chopra ( Chopra Centre for Well Being), Desh Deshpande (Cascade Communications), Vinod Dham (Intel, NextGen, Silicon Spice), Prabhu Goel ( Gateway Design, Ipolicy), Rajat Gupta (McKinsey), Vinod Khosla (KPC & Byers), et al… (25 in all) 04/24/09

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The first Entrepreneur - Venture? • • • • • • • •

1492 A.D.: Europe’s period of “Liberalization” Voyage to discover a sea route to China, Japan… Sail West, with active support of the monarch… King of Portugal and his Committee… rejected ! Project was patronised by the Spanish Monarch About six years, many rounds of deliberations… Supported by Queen Isabella, a new direction … Christopher Columbus could launch his voyage ! 04/24/09

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Venture Capital • • • • •

Development after Second World War Shift from Tech-oriented Mfg Orgns Unlisted Companies Finance to Non-conventional units Risky financing to new ventures based on innovative entrepreneurship • Started in USA, UK, European countries • Followed in East - Japan, Singapore, etc 04/24/09

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What is Venture Capital ? • Money provided by Professionals or Wealthy – High Networth Individuals (HNIs) or Institutions like FIIs, FIs, etc who invest alongside management in young rapidly growing companies that have the potential to grow into significant economic contributors • It’s an important source of equity for start up co’s 04/24/09

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VC Firms • Generally private limited liability partnerships • Or closely held corporations funded by : – – – – – – –

Private & public pension funds Endowment funds Foundations Corporations Wealthy individuals Foreign investors and Venture Capitalists.. 04/24/09

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VCF in the West • • • • • • •

New, tech-based professionals Untried areas ventured by entrepreneurs Inadequate investment VC and Entrepreneurs work as partners High risk, High returns (capital gains) No Security or Collateral High growth rate expected

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Some novel Ventures • Federal Express Corpn - Courier industry was revolutionized with overnight delivery! • Edwin H. Land - initially failed to convince Detroit Auto Industry with polarizing headlights - Then, invented Polaroid Camera ! • Haloid Corporation funded inventor of Xerox - Mr. Chester Carlson for Photocopying ! 04/24/09

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Features of VC • Equity Participation • Long Term Investment • Participation in Management 04/24/09

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VC in USA • Post War - 1946 : Formulation of American Research and Development Corporation (ARDC) in Boston : Gen. Georges Doroit, a French-born military man – considered as Father of VC – Taught Risk Capital at HARVARD BS • J H Whitney’s Minute Maid (1946) Orange Juice • Rockfellers’ VENROCK in 1950 – Eastern Airlines • SBIC Act, 1958 for financing VCs • Tax Incentives to VCFs • Reduction in Capital Gains Tax in 1978 04/24/09

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Growth of VC in USA • 01. Favourable Public Attitude • 02. Dynamic Financial System • 03. Government Support 04/24/09

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VCs in Europe • Started in the Eighties - Slow growth • European Venture Capital Assn-1983 • Change in Public Policy & Economic conditions • Banks, Govt, Insurance Cos, Pension Funds and Corporate Investors • Focus on Industrial, Consumer and Electronic Products 04/24/09

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VC in UK • Largest VC industry outside USA • Steady growth of finance and talent • Demonstration Effect of high profitability • Tax incentives for investments in VCF • Business Expansion Scheme to motivate • Increase in Management Buy Outs • Involvement ofVenture Merchant 04/24/09 Capital Finance Bankers

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VC in Other Countries • France - 50 % fiscal incentives from 1972 • More tax incentives from 1983

• Netherlands - fast growing VC market • Owned and supported by Banks/Govt

• Germany - 75 % Family owned Cos • Change in attitude since 1985 04/24/09

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VC in Asia • Initially supported by friends, relatives etc • Japan started Small Business Investment Companies in Sixties • Australia launched VC in seventies • Hong Kong, Singapore, South Korea and Taiwan in the beginning of eighties • Government Policy favourable to VCs 04/24/09

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VC - Defined • …….. An equity/equity-related investment in a growth-oriented small/medium business to enable investees to accomplish corporate objectives, in return for minority share-holding in the business or the irrevocable right to acquire it. 04/24/09

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Who is an Angel ? • An important link in the process • • • • • • •

Who supports an enterprise At a very early stage An experienced individual Who is a Professional with High Net Worth Provides “First Round” finance With “less” money orientation 04/24/09

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Steps in VC Financing • • • • • • •

01. Selection of Investment 02. Stages of Financing 03. Financial Analysis 04. Structuring the Deal 05. Investment Nurturing/Aftercare 06. Valuation of Portfolio 07. Exit

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01. Selection of Investment • Evaluate Business Plan of VCU (promoter) • Similar to Project Appraisal by DFIs • Track record of the Entrepreneur • Market Potential Study and Projects • Profitability Study • Likely threats to project o/a technological obsolescence/ competition 04/24/09

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02. Stages of Financing • Early Stage Financing – Seed Capital/pre-Start Up – Start up – Second round financing

• Later Stage Financing – – – – 04/24/09

Mezzanine/Development Capital Bridge/Expansion Buy Outs - MBOs and MBIs Turnarounds Venture Capital Finance

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03. Financial Analysis • Idea-based and growth-based ventures ? • 01. Conventional VC Valuation Method – Evaluates VCU at starting and exit time

• 02. The First Chicago Method – Evaluates entire earnings stream

• 03. Revenue Multiplier Method – Annual revenue is estimated thro’ Multiplier 04/24/09

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04. Structuring the Deal • • • • • • •

Equity Instruments Debt Instruments Conditional Loan Conventional Loans Income Notes, NCDs, PCDs Zero Interest/Coupon Bonds/Debentures Secured Premium Notes, Deep Disc Bonds

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05. Investment Nurturing/ Aftercare • Styles – Hands-on Nurturing – Hands-off Nurturing – Hands-holding Nurturing

• Objectives of Aftercare • Techniques - Personal Discussions, Plant Visits, Feedback thro Nominee Directors, Periodic Reports, Commissioned Studies 04/24/09

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06. Valuation of Portfolio • Equity Investments – Cost Method, Market Value Method, Quoted Market Value Method, Fair Market Method,etc

• Debt Instruments – Convertible Debt, Market Value Method, Fair Value Method, Non-Convertible Debt, Fixed Interest Non-Convertible Debt, Highly leveraged Investments 04/24/09

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07. Exit • • • •

Last stage in VC Financing To make profits or minimise losses ! Timing decided in advance / well planned Timing depends on – – – –

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Nature of Venture Extent and type of finance state of competition market conditions, etc Venture Capital Finance

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Disinvestment Channels • VOLUNTARY • • • •

Going Public Sale of Shares to Entrepreneurs /Employees Trade Sales / Sale to another company Selling to a new investor

• INVOLUNTARY • Liquidation / Receivership 04/24/09

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VC in India

• An equity finance in new companies • As loan / convertible debt for capital gains • Long Term investment in growth oriented small / medium firms to help them grow rapidly • Active involvement of VCs to promoters extending “hands-on” approach / management • High-risk-return; Compensation for other losses • Not a technology-finance; early stage support 04/24/09

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Indian VC History • VC financing – 1975 – IFCI-sponsored Risk Capital Foundation (now IFCI Venture Capital Funds Ltd.)

• 1976 – Seed Capital Scheme – Industrial Development Bank of India (IDBI).

• Till 1984 - risk and seed capital • Need felt during 1985-investors burnt their fingers • 1985 - VC fund – Government of India (GoI) 04/24/09

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Indian VC Scenario • • • • • • •

Need felt in 1985 - Failure of Small Issues GOI Long Term Fiscal Policy - 1985 DFIs lead VC Financing thro TDICI, RCTC Fiscal Incentives announced in 1988-89 CCI (1988) / SEBI 1995-96 Guidelines VCFs made on par with MFs by CBDT KB Chandrasekhar Committee 1999-2000

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KBC Recommendations-2000 • • • • • • • •

Harmonisation of Multiplicity of Reglns. VCF Structures Resource Raising Investments Exit SEBI Regulations Company Law related issues and Other related issues

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SEBI - FVCIs Regns, 2000 • • • • • • •

Definition of FVCI Registration Investment Criteria General Obligations and Responsibilities Inspection and Investigation Procedure for action in case of Default Structure, etc.

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SEBI amends norms to VCFs • Business Line dt April 15, 2004 • SEBI Committee headed by Dr Ashok Lahiri, CEA, MOF • Can invest in Real Estate, NBFCs in Eqpmt Leasing and HP activities, Companies engaged in Gold Financing in Jewellery • Minimum Investment Limits altered • Allowed to invest in financially weak companies whose shares are listed • 1-year lock-in of shares on listing removed • Allowed to invest in Special Purpose Vehicles 04/24/09

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To name a few VCs • • • • • • • • •

APIDC Venture Capital Ltd., Hyderabad Canbank Venture Capital Fund Limited, Bangalore Gujarat Venture Capital Fund Ltd, Ah’bad Industrial Venture Capital Ltd., Chennai Auto Ancilliary Fund, New Delhi Karnataka Information Techonology V C Fund Tamilnadu Technology Fund Orissa V C Fund, U P Venture Fund SICOM (Mumbai), Punjab Infotech Venture Fund… 04/24/09

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SIDBI • Set up under an Act, as a Principal Financial Institution for promotion, financing and development of Industry in the Small Scale Sector • SIDBI – Venture Capital initiatives – created a Three Tier Venture Capital Structure at – State / Regional level (12 VC Funds dedicated to IT) – National level – Rs 1000 mn (USD 22 mn) for IT – Other all India Funds

• In Gujarat, Maharashtra, Tamil Nadu, Karnataka, Punjab, Kerala, Andhra Pradesh, Rajasthan, etc. 04/24/09

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Growth of VC in India • • • • • •

1996-97 1997-98 1998-99 1999-2000 2000-01 2001-02

• 2007-2008 estd.. 04/24/09

• • • • • •

Rs. 70 crores 320 610 2,200 5,300 8,400

• 50,000 Venture Capital Finance

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Major Contributors in VC • FIIs • D F Is in India • Multilateral Development Agencies • Individuals and Companies • Other Banks 04/24/09

• 51 per cent • 23 per cent • 9 per cent • 11 per cent • 6 per cent Venture Capital Finance

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Venture capital financing to IT sector

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New Technology Financing Success Rates 6 in 1000 business plans get funded on average The No 1 reason a start-up’s valuation is cut due to incomplete executive teams 10% of start up in a given venture capital portfolio will succeed 6 out of 1,000,000 of technology ideas will result in IPO

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Life Cycle of an Enterprise

Market Expansion Busin ess Plan

Pro duct Developm ent

Con cept Ma rk et Va lidat ion S eed Fun d

B uilding a sus tainable B us ine ss

IP O

Marke Markett Do Dom minan inance ce

Ea rly C us tome rs

V ali date

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Technology Growth and Life-style Companies

revenue

Maturity

IPO, Acquisition Rapid growth and ramp-up Idea

R&D Prototype Debt Financing

Private Venture Capital Investors Angel Financing 04/24/09

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Life Style

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time

DRIVERS OF VENTURE INVESTING IN INDIA • Knowledge based industries growing fast and mostly global; less affected by domestic issues • World class engineers, professionals, entrepreneurs • 2nd largest English speaking population; science and mathematics at a premium • India has advanced rapidly in the 90’s, catching up with global markets in many sectors • Evidence of this in the US as well  25% of small IT companies in the US have Indian founders  Disproportionately large presence of Indians in the US Software Sector (1 million?)  50% of all H1 visas issued to Indians

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REGULATORY ENVIRONMENT • • • • •

The Indian Trust Act, 1882 or the Company Act, 1956 The Foreign Investment Promotion Board (FIPB) and the Reserve Bank of India (RBI) in case of an offshore fund The Central Board of Direct Taxation (CBDT) governs the issues pertaining to income tax The Securities and Exchange Board of India has come out with a set of guidelines Government of India – Ministry of Finance that may have to be approached in certain situations. Also intervention by allied agencies like the Department of Electronics, the National Association of Software and Computers (NASSCOM) and various taskforces and standing committees is not uncommon.

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Venture Capital Funding • Venture Capital Funding started with Christopher Columbus’s voyage and later helped industrialisation all over the world in the last century. In the last thirty years, VCCs or VCFs in India were witnessing policy changes leading to Private Equity boom now 04/24/09

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Private Equity • Private Equity is medium to long-term finance provided in return for an equity stake in potentially high growth unquoted companies. Private equity in the UK originated in late 18th century, when entrepreneurs found wealthy individuals to back their projects on an ad hoc basis. This informal method of financing became an industry in the late 1970s and early 1980s when a number of private equity firms were founded and recognized as asset class. 04/24/09

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Private Equity • Comprises of all venture investing, buyout investing and mezzanine investing. • Mezzanine investment financing provides for major expansion in companies whose sales are increasing, and whose cash flow is break-even or slightly positive. • Does not include angel investors, real estate investments or other investing scenarios outside of the public market. 04/24/09

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Difference between VC and PE • A VC is a subset of the larger PE asset class. The PE asset class includes VC, buyouts, and mezzanine investment activity. VC focuses on investing in private, young, fast growing companies. Buyout and Mezzanine investing focuses on investing in mature companies (www.iciciventure.com). • In the Indian context, VC funding is extended generally to idea-based, start-up and unlisted companies. The present trend of PE funding is flowing into existing growth oriented companies which may be listed or unlisted. 04/24/09

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Developments • Throughout 1990s the technology hype, internet boom and massive capital investment propelled the New Economy revolution, but internet mania in the late 1990s caused IEC stocks to skyrocket until the dot com bubble burst in March 2000. SEBI then formulated latest guidelines for VCs on the basis of KB Chandrasekhar Committee. There is currently availability of abundant PE funds in India. 04/24/09

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Sectoral break-up of M & A and PE Deals – 2005 and 2006

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